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performance improvement by means of acquisition entry mode (Brouthers & Dikova,2010).In an acquisition, the foreign company merges or acquires an established entity in anothercountry thus accomplishing an extensive form of participation – 100 % of ownership(Elango & Sambharya, 2004; Al-Kaabi et al, 2010). This means that the acquiring firm hasfull managerial control (Newburry & Zeira, 1997). In comparison to greenfield or JV,acquisitions can be realized much faster and because of this are preferred as entry modewhen time plays an important role (Elango & Sambharya, 2004). This is the case when, forexample, a company wants to enter a certain market quickly in order to secure a firstmover advantage (Newburry & Zeira, 1997).Cross-border M&As give companies the opportunity to access new markets, as well as togain new knowledge and acquire new capabilities (Shimizu et al, 2004). However,acquisitions require full resource commitment right at the beginning of the project(Brouthers & Dikova, 2010).M&As have, however, have a few weak points which have to be considered whenchoosing entry mode strategy. Brouthers & Dikova (2010) state that acquisitions are notalways the best possibility when expanding, especially into international markets. Asstarters acquiring a firm calls forth a couple of challenges in managing the acquiredbusiness (Meyer et al, 2009). More precisely, managers at multinational enterprises(MNEs) of the buying company face the following problem: they have to assimilate theexisting national and organizational culture, and policy (Newburry & Zeira, 1997).Furthermore acquisitions are often in danger of cultural clashes between parent andacquired entities, which impedes knowledge flow (Brouthers & Dikova, 2010). Dikova andWitteloostuijn (2007) endorse this assertion and state that coping and managing the processof overcoming the liability of foreignness could be difficult without a local partner. Inaddition to that there is also a financial risk. The acquiring company has full or near-fullresponsibility for the potential success or failure of the acquired firm (Newburry & Zeira,1997). Moreover acquisitions are expensive and companies make considerable nonreversible (or semi- reversible) resource commitment, which increase the risk by a possiblefailure even more (Brouthers & Dikova, 2010). Shimizu et al 2004 add another weak pointof M&As by arguing that uncertainty and information asymmetry in foreign marketsimpede adjustment and learning from both the local market and the target company(Shimizu et al, 2004).8

2.1.2 Joint ventures“An equity international joint venture is a separate legal organizational entity representingthe partial holdings of two or more parent firms, in which the headquarters of at least one islocated outside the country of operation of the joint venture. This entity is subject to thejoint control of its parent firms, each of which economically and legally independent of theother” (Newburry & Zeira, 1997, p. 89). Elango and Sambharya (2004, p. 110) furthermoredefine joint ventures (JV) as:”a partnership wherein the venture (business) is jointly ownedby two or more firms”. Shared ownership – such as JVs – gives the possibility to share notonly risk, but also strengths, especially local market knowledge of aimed market partner(Al-Kaabi et al, 2010). Kirby & Kaiser 2001 also share this assertion: “JV can be seenprimarily as a device to gain access to resources embedded in other organizations and, [ ]and as a mean of acquiring local management expertise and connections in order tofacilitate fast entry into new markets”. Furthermore this entry mode allows more flexibilityin the sourcing and deployment of resources. This on the other hand facilitates theovercoming of industry barriers and minimization of risks of liabilities of foreignness(Elango and Sambharya, 2004). Another advantage of the JV is that having a local partner“can help firms gain legitimacy because partnering with a local firm can help it createstructures and activities that conform with local norms, va lues and expectations”(Brouthers et al, 2008, p. 193).However JVs is not a perfect entry mode – it hast its disadvantages as well. First of all,having to work with partners makes management and other activities more complicatedbecause there are multiple viewpoints that need to be thought through by formulatingbusiness policies and strategies (Newburry & Zeira, 1997). Dikova & Witteloostuijn(2007) furthermore discuss the difficulties coming from different interests and goals. Incomparison to acquisitions where the investor has access to all resources, in JVs only theresources placed by the local partner are accessible (Meyer et al, 2009).2.1.3 GreenfieldThere are many definitions of the greenfield entry mode. New and Zeira (1997, p. 89)define it as follows:”An international greenfield investment is the establishment of a newaffiliate in a foreign host country by a company headquartered outside the country wherethe investment is occurring for the purpose of producing a company‟s product or providinga company‟s device”. Shimizu et al (2004, p. 311) give another definition:”Greenfield9

ventures involve establishing wholly owned subsidiaries in new geographic markets”.Elango and Sambharya (2004, p. 109) furthermore define greenfield as:”a foreign firmstarts operations on its own in a host country”. As it can be noticed there are two importantcharacteristics of this entry mode, mentioned in all of the above listed definitions: newaffiliate (started from scratch) and taking place in a foreign country.There are several reasons for choosing greenfield as an entry model. First of all, it enablesthe establishment of common organizational culture and thus making knowledge transferfrom the new affiliate to the parent company easier (Brouthers & Dikova, 2010). All of thisis possible because entering a foreign market by means of a greenfield secures theinvesting company full control over the local operations (Dikova & Witteloostuijn, 2007).This is especially important in emerging economies, where property rights protection isweak, because in this way competitive advantage is better protected (Dikova &Witteloostuijn, 2007). Another advantage of the greenfield entry strategy concerns thefinancial part. This kind of entry mode requires “lower upfront investments and henceminimize(s) downside risks” (Brouthers & Dikova, 2010, p. 1049). In addition to thatgreenfields give an opportunity to make bigger investments by favorable conditions orabandonment at considerable lower price when things don‟t turn out as expected(Brouthers & Dikova, 2010).One of the critique points of greenfield ventures is that they have a longer establishmentperiod and need more time in order to build local business networks (Dikova &Witteloostuijn, 2007). Furthermore although they require lower investments, by a potentialfailure the financial exposure is bigger in comparison to JVs, where ownership is divided(Newburry & Zeira, 1997). Another weak point of the greenfield entry mode is theovercoming of liability of foreignness without the support of a local partner (Dikova &Witteloostuijn, 2007).In the table below the advantages and disadvantages of the three entry modes aresummarized.10

Table 1: Entry modes advantages and disadvantagesMode of entryGeneralAdvantagesM&A Merging with oracquiring anestablishedentity in aforeign country An extensiveform ofparticipation(100%ownership) Full managerialcontrol (fullownership) M&As can berealized very fastfirs moveradvantage Access to newmarkets,knowledge andcapabilitiesJoint venture The business isjointly owned bytwo or morefirms Theheadquarters ofat least one islocated outsidethe country ofoperation of thejoint venture Establishing awholly ownedsubsidiary It takes place ina foreigncountry Shared risk More flexibility inthe sourcing anddeployment ofresources Having a localpartner who canhelp in gaininglegitimacyGreenfield Possibility forestablishment ofcommonorganizationalculture Full control overlocal operations Flexibility regardingLong establishmentperiodsize of investmentsDisadvantages Need forassimilation ofthe national andorganizationalculture and policyof the acquiredcompany Danger of culturalclashesknowledge flow isimpeded M&As areexpensive High financial risk( full or near-fullresponsibility) Uncertainty andinformationasymmetryimpedeadjustment andlearning Having a partnercan make theworking processmore complicated Different interestsand goals Only theresources placedby the localpartner areaccessible By potentialfailure financialexposure is biggerOvercoming ofliability of foreignnesswithoutthesupport of localpartner11

2.2 Institutions and entry modesIn this section the relationship between institutions and entry mode choice is going to bediscussed.North (1990, p. 3) define institutions as “the rules of the game in a society or, moreformally, are the humanly devised constraints that shape human interaction”. Thisdefinition includes formal institutions – laws and regulations, and informal – customs,norms and cultures (Meyer & Peng, 2005).A new direction of research argues that institutions are nowadays much more than just“background conditions” (Meyer et al, 2009). Researchers have realized that institutionshave significant importance and it is no longer possible for strategy research to concentrateonly on industry conditions and company resources (Peng, 2002). Institutional theory hasturned out to be a strong and useful instrument for analyzing individual and organizationalactions over the time (Dacin et al, 2002). One of the reasons for that growing interest isthat it provides a rich theoretical basis for examination of a wide range of critical problems.Furthermore institutional theory gives an opportunity for theory building at various levelsof analysis, which is of a significant importance for multinational company (MNC)research (Kostova et al, 2008).Dikova and Witteloostuijn 2007 discuss the importance of institutions in terms of degree ofinstitutional advancement – “the extent to which market-economy-consistent rules of thegame are operational” (p. 1015). Formal and informal institutions take part in theinteractions between companies and in this way “affect the relative transaction andcoordination costs of production and innovation” (Meyer et al, 2011, p. 237). Institutionsare furthermore accountable for the transfer of corporate social responsibility (CSiR). Morespecifically the less developed the institutional environment in a host country, the morelikely MNEs will carry over their CSiR practices to the subsidiaries (in the host countries)(Surroca et al, 2013).Institutions have a significant role in a market economy. They have to sustain the effectivefunctioning of the market mechanism. This would make it possible for companies andindividuals to participate in market transactions without causing unwanted costs and risks(Meyer et al, 2009). When markets function without difficulties in developed countries, themarket-supporting institutions cannot be noticed. On the other hand when markets do not12

function properly, like in emerging economies, the absence of stable formal institutions institutionalmodel“organizational survival is determined by the extent of alignment with the institutionalenvironment; hence organizations have to comply with external institutional pressures”(Kostova et al, 2008, p.997). This would explain why institutional differences areespecially important for MNEs operating in various institutional environments (Meyer &Peng, 2005).Another aspect of the institution based- view is that it influences on firms‟ strategic choicesand strategies like, for instance, entry mode (Meyer et al, 2009) and defines the possibilityfor bargaining between investors and authorities (Meyer & Peng, 2005). More specificallyDikova and Witteloostuijn (2007) argue that greater institutional advancement is aperquisite for acquisition establishments. This is thesis is also supported by Meyer andPeng (2005). They state that by less developed formal marketing supporting institutionsMNCs would choose JVs and alliances as opposed to wholly owned subsidiaries as anentry strategy.2.3 Institutions and entry modes in emerging economiesAs already mentioned strategies in transition economies (also considered as emergingeconomies, Hoskisson et al, 2000) considerably differ from those in developed ones.Because of this, they can be only explained by taking into consideration the specificinstitutional environment when making an analysis (Meyer, 2002). Moreover companiesthat manage to adapt to institutional “pressures” have better chances at acquiring scarceresources and surviving on the foreign market (Newman, 2000).“An emerging economy can be defined as a country that satisfies two criteria: a rapid paceof economic development, and government policies favoring economic liberalization andthe adoption of free market-system” (Hoskisson et al, 2000, p. 249).The end of the Communism era (1989) freed a new wave of rapid-growth countries in CEE– transition economies. They were aiming at supporting their market mechanism throughliberalization, stabilization and encouragement of private companies (Hoskisson et al,2000). This in its turn has attracted a huge amount of foreign direct investments (FDI) andtrade (Gelbuda et al, 2008). However, the attention of researchers was only recently drawnto the influence of institutions on economic performance (Pournarakis, 2004).13

When the communist system had fallen institutions were not in the position to reduceuncertainty and manage stable structure to support interactions and thus reduce transactioncosts (Meyer, 2001). Slowly formal institutions were formed. This period of constructionis, however, characterized by various difficulties for the international business: overlappingand contradictory legislation, vacuum with incomplete legal frameworks and blurred socialnorms. In addition to that Western companies entering emerging markets had to cope withhigh transaction costs, corruption and low protection of property rights (Meyer, 2001).Consequently this transition process could be really challenging for MNEs (Gelbuda et al,2008). Brouthers (2002) support this by stating that institutional structure weaknesses suchas legal restriction on ownership could be a cause for entry barriers.Institutions also ensure information about business partners and their potential behavior.This on its turn reduces unwanted information asymmetries, which are often a reason formarket failure. As already mentioned, many emerging economies have weak institutionalenvironment and this could cause informational asymmetries. Because of this companiesrun into difficulties and risks regarding partnerships and thus the y have to invest moreresources in information search (Meyer et al, 2009).Meyer et al (2009, p. 63) classified institutions as: “strong” – “they support the voluntaryexchange underpinning an effective market mechanism - and “weak”- “they fail to ensureeffective markets or even undermine markets”. This is especially important for thecompanies operating internationally because formal institutions define the permissibleentry modes (Meyer et al, 2009). For instance, legal restrictions could limit foreign equityownership (Delios & Beamish, 1999).Hypothesis 1a: (The) Weak formal institutions (in Bulgaria) impede the foreign directinvestment process in the country.O‟Cass et al (2012) furthermore argue that an entry mode decision has an influence on theentire company‟s strategy on a certain market. In countries

Master Thesis Business Administration Formal institutions and entry modes in developing countries in Eastern Europe - the case of Bulgaria Author: Tsvetelina Stoyanova Student number: s1025007 Track: International management First supervisor: Dr. M. L. (Michel) Ehrenhard Second supervisor: R. P. A. (Raymond) Loohuis Date: 15.08.2015